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Credit Cards and College Tuition... a Bad Mix

Monday, June 30, 2008

For many of you, student loans may seem scary, confusing, and a little overwhelming. You have to understand terms like grace period, deferment, and borrower benefits. You may need a co-signor to get a private loan and school certification to get a Stafford loan. By contrast, applying for a credit card may seem like a piece of cake. However, don't be fooled. Taking out a student loan to pay for college is almost always a better way to pay for college than charging tuition to a credit card.

Student Loans Have Better Interest Rates than Credit Cards

Any student can take out a Stafford loan, which has a fixed interest rate of 6.8%. Credit cards can often have annual interest rates that are as high as 18% or 19%. Even interest rates on private loans don't get close to that high.

Student Loans Typically Don't Capitalize Interest Until Graduation

It's not just the interest rates that can cause your debt to balloon. Credit card debt typically capitalizes every month. That means your interest rate is applied to your entire outstanding balance. Student loan debt typically capitalizes after graduation, meaning your interest rate is only applied on your original loan amount until graduation (not on the principal plus the monthly interest). Here's a simple example:

Let's assume you need $10,000 to pay for tuition and other fees freshman year. For simplicity, let's say that you can get a credit card with 8% annual interest (which is unlikely) or take out a loan with an 8% interest rate. The only difference is the interest on the credit card capitalizes monthly and the interest on the student loan doesn't capitalize until graduation. Let's say it takes you 4 years to complete college. After 4 years, you will owe $13,757 on the credit card and $13,200 on the student loan. You'll owe nearly $600 more with the credit card, and that's assuming the credit card and the student loan have the same interest rate.

Credit Cards May Hit You with Lots of Fees or Increased Interest Rates

Make sure you check out the fine print on credit cards. There may be late fees, over-the-limit fees just to name a couple. You may also start at a low interest rate, but then trigger a higher interest rate because of a missed payment or a large outstanding balance.

Again, you will almost always make out better taking out a student loan to pay for college than putting tuition on a credit card.